Business Context and Reporting Period
Company: FS Investment Corporation (FS KKR Capital Corp)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Business Overview: The Company is an externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). Its primary objective is to generate current income and, to a lesser extent, long-term capital appreciation through investments in senior secured loans, second lien secured loans, and mezzanine debt of private U.S. companies.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2010 | Nine Months Ended Sep 30, 2010 | Dec 31, 2009 (Balance Sheet) |
|---|---|---|---|
| Investment Income | $8,678 | $17,872 | N/A |
| Net Investment Income | $3,559 | $7,809 | N/A |
| Net Realized Gain on Investments | $294 | $3,383 | N/A |
| Net Change in Unrealized Appreciation | $7,902 | $1,811 | N/A |
| Net Increase in Net Assets from Operations | $11,848 | $13,000 | N/A |
| Total Assets | N/A | N/A | $536,585 |
| Total Liabilities | N/A | N/A | $274,704 |
| Stockholders' Equity | N/A | N/A | $261,881 |
| Net Asset Value (NAV) per Share | N/A | N/A | $9.27 |
| Cash and Cash Equivalents | N/A | N/A | $35,957 |
| Investments at Fair Value | N/A | N/A | $480,879 |
| Debt Outstanding (Credit Facility) | N/A | N/A | $197,267 |
Note: All figures in thousands except per share data.
Material Changes vs. Prior Period
- Portfolio Growth: Total investments at fair value increased from $100,592 (Dec 31, 2009) to $480,879 (Sep 30, 2010), driven by significant capital raising and deployment. The portfolio now consists of 106 companies compared to 50 in the prior year.
- Revenue Expansion: Investment income for the nine months ended Sep 30, 2010, was $17,872, a substantial increase from $2,081 in the same period in 2009. This reflects the scaling of the asset base.
- Expense Increase: Total operating expenses rose to $10,063 for the nine months ended Sep 30, 2010, from $1,515 in the prior year period. This includes $2,213 in interest expense related to the new revolving credit facility, which did not exist in the prior period.
- Debt Financing: The Company established a revolving credit facility with Deutsche Bank. As of September 30, 2010, $197,267 was outstanding. There was no credit facility debt as of December 31, 2009.
- Unrealized Gains: While the three-month period showed a significant unrealized appreciation of $7,902, the nine-month total was $1,811, compared to $6,503 in the prior year's nine-month period, indicating volatility in credit market valuations.
Guidance, Outlook, and Risks
- Capital Raising: The Company continues a continuous public offering. As of November 12, 2010, it had raised gross proceeds of $339,185. The public offering price was increased to $10.50 per share in November 2010.
- Distributions: The Board increased semi-monthly distributions to maintain an annual yield of 7.35%. Distributions are funded primarily by net investment income (73%) and capital gains proceeds (27%) for the nine months ended Sep 30, 2010.
- Credit Facility Amendments: In November 2010, the Company amended its credit facility to increase the maximum borrowing capacity from $240 million to $340 million. Borrowings bear interest at LIBOR plus a spread (ranging from 1.50% to 2.23% depending on the tranche).
- Risk Factors:
- Interest Rate Risk: The majority of the portfolio pays variable rates. Rising rates increase income but also increase the cost of the Company's floating-rate debt.
- Valuation Risk: All investments are classified as Level 3 (unobservable inputs) within the fair value hierarchy, relying on dealer quotes and third-party pricing services.
- Liquidity: The Company relies on the continuous offering and the credit facility for liquidity. The credit facility is subject to borrowing base limitations and "Super-Collateralization Events."
- Management Commentary: Management notes that credit spreads have declined from 2009 lows but remain above historical averages. The portfolio's weighted average credit rating is B2 (Moody's scale), and the estimated gross annual portfolio yield is 9.0%.
Investor Verification Checklist
- Debt Covenants: Verify compliance with the borrowing base and "Super-Collateralization Events" in the Deutsche Bank credit facility, which could restrict future borrowing or require asset sales.
- Distribution Sustainability: Confirm the source of distributions (Net Investment Income vs. Capital Gains vs. Return of Capital) via the annual Form 1099-DIV, as quarterly data may not reflect full-year tax attributes.
- Valuation Methodology: Review the Level 3 fair value roll-forward to understand the impact of unobservable inputs on the reported Net Asset Value (NAV).
- Expense Ratios: Monitor the ratio of operating expenses to average net assets (5.71% for the nine months ended Sep 30, 2010) to ensure it remains competitive as the asset base grows.
- Portfolio Concentration: Assess industry concentration, noting that Information Technology (20.7%) and Industrials (18.6%) represent the largest sectors in the portfolio.